Hologic looks for fresh traction

Bedford-based medical device and diagnostics company Hologic (Nasdaq: HOLX) has made a big bet with its $3.9 billion acquisition of San Diego, Calif.-based diagnostics firm Gen-Probe (NASDAQ:GPRO), in its effort to become the leader in women’s health devices and diagnostics.

Hologic says combined revenue for the two companies over the past twelve months is $2.45 billion, and the merger will achieve $75 million in cost reductions between the two firms in the next three years. But investors have balked at the price tag of the deal, which is expected to close in August and will be almost entirely financed with debt.

“We believe Gen-Probe is an ideal partner and strategic fit to Hologic’s existing diagnostics business and that this combination complements our focus on women’s health and adds diversification to our portfolio of leading products,” Hologic CEO Rob Cascella said on a conference call with investors when the deal was announced. Cascella declined to be interviewed for this story.

Hologic is best known for its mammography machines, but operates in four business segments, with 57 percent of its business in disposables, 25 percent in capital equipment and 18 percent in services.

The Breast Health division includes breast biopsy devices, and digital mammography, including its recently approved 3-D mammography device, the first of its kind on the market. Hologic’s GYN Surgery includes the Myosure device for treating uterine fibroids, an asset acquired when Hologic bought Framingham, Mass.-based Interlace Medical Inc. for $125 million in January of 2011.

Hologic sees Gen-Probe’s product line dovetailing with the company’s Diagnostics division, which includes pre-natal tests, as well as pap test and human papillomavirus testing (HPV), which can identify patients at risk for cervical cancer. Gen-Probe offers complementary HPV screening tests, as well as tests for other sexually-transmitted diseases, including gonorrhea and chlamydia. Hologic executives, in regulatory documents, describe significant upside potential for the Gen-Probe tests, by expanding their reach into Europe, and by introducing the tests in China, where Hologic has a workforce of more than 500.

Hologic executives said its $75 million cost-cutting program will increase margins at the combined company to 37 percent, up from 34 percent for Hologic and 32 percent for Gen-Probe. Hologic’s net income for fiscal 2011 was $157.2 million, on revenue of $1.79 billion, while Gen-Probe’s 2011 profit was $50.1 million on revenue of $576.2 million.

But Hologic’s shares dropped 10 percent on April 30, when the acquisition was announced, and have fallen another 5 percent since then.

“The deal was so unexpected, that it kind of clouded the investment thesis on the company, which had been focused on growth of the 3-D mammography business,” Raj Denhoy, an analyst at Jefferies & Co., said. “Suddenly the largest part of the business is in molecular diagnostics.” Denhoy said the benefits of the merger look attractive long term, but uncertainty remains in the short term.

One investor concern is the company’s increased leverage after the purchase.

“If sales of the new products fail to meet estimates, the company’s performance will be adversely affected,” a report from Zacks Equity Research stated. “We remain concerned about the current high level of leverage that will lead to high interest rates, thereby affecting the bottom line.”

Other analysts see the recent stock weakness as a buying opportunity.

“We are not huge fans of the Gen-Probe deal, in light of other potential uses of $3.7 billion,” J.P. Morgan Chase & Co. analyst Tycho Peterson wrote in a recent research note, “and we think it will be difficult to achieve value creation with this deal.” But with the stock battered in recent weeks, Peterson said the risk/reward is too compelling to ignore, and upgraded the stock to “Buy” from “Hold.” Peterson does believe there is significant growth potential for the HPV screening business, citing a JP Morgan physician survey that showed that while only 48 percent surveyed use HPV testing today, 83 percent plan to use the tests in the future.